Are We Speculating Because Interest Rates Are So Low?

Investment Perspective – June 2015

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Last month in the Investment Perspective I raised once again the idea that many investors, particularly those who are inexperienced, sometimes struggle to tell the difference between investing and speculation. Although not always, speculation can revolve around the lure of quick easy gains without much effort.

At the same time, it is interesting to watch investor behaviour in the current investment climate with mountains of printed money, debt and interest rates at lows levels that in some economies have never been seen before.

This is not normal. The challenge though is that the current environment has been building up for many years and looks as though it might continue on for a while yet.

As a client and I discussed and agreed recently in Invercargill, the central bankers at this stage have control over the global economy and have engineered economic stability which appears to be in place, at least for now.

It is difficult to predict the future, particularly in this environment which has never really been seen before, however it looks as though stability might remain in place for the next year or two.

Let’s Keep An Eye Out For Interest Rate Rises Though …

It seems to me that the US Federal Reserve is working hard on manufacturing a delayed, slow and non-threatening increase in interest rates. At least up until now it appears to be working and I suspect will continue to work at least in the short term. The interest rate rises will only be on the back of solid economic data such as the recent unemployment numbers coming out of the United States of America. 

Another number to watch is the producer’s price index which ideally should remain above 50, denoting economic growth and expansion. Whilst there are other numbers we can watch, these two in particular are fundamental drivers of economic growth when they head in the right direction. 

The Challenge

The challenge is though, that asset prices are high and to some extent based on those low interest rates. Investors with significant sums of money have chased the capital gains and high dividend yields in the absence of being able to obtain them elsewhere. 

To put this another way, investors (and some speculators) have themselves pushed asset prices up to unrealistic levels that will be difficult to maintain as interest rates normalise at some point in the future.

Keeping It Real

Of course for us as Value Investors, whilst it is not that the businesses in which we invest will be immune to price declines, we have some comfort in the knowledge that the underlying business economics are sound. This is particularly important when the economy faces significant challenges. 

For example, Google has a strong balance sheet. 46% of Google’s balance sheet is in cash.  Even if the trading price (the share price) declined by say 20% the cash is still there. Price and value are different things.

It is all very well making money whilst things are easy. It is another matter to build wealth through thick and thin. Investing in the sound business economics instead of speculating on the share price means we get to sleep soundly at night – no matter what.

“You can’t tell who’s swimming naked until the tide goes out.“

Warren Buffett